1. Ms Victoria is the Investment Manager and has requested some analysis concerning a proposed 5-years investment. The company plans to open a showroom in York and have narrowed their selection down to two locations: (1) City Centre and (2) Clifton Moor. You have to evaluate these options based on the following information. Daffodil will lease the showroom initially for 5 years, and the total initial cost of investment is estimated to be f10 million each. Option one: City Centre It is expected that the City Centre showroom will increase the overall sales revenue of the company by 10% per annum from 2020, and the variable cost will be forty-two percent of sales revenue. The fixed overhead cost will be 3,500,000, 2,000,000 and 1,500,000 in the first, second, and third years. The promotion cost will be 500,000 in the first two years and 200,000 for the next three years. All other expenses will be 10% of the total contribution margin. In the second year, the company will need a working capital investment of 2 million, and 60% of which will recover at the end of project life. The company follows a straight-line depreciation method and expects to sell the assets at 20 % of historical cost in year 5. Option two: Clifton Moor On the other hand, if the shoWroom is opened at Clifton Moor, then it will require fixed overhead cost for four years L2,500,000 in year one, 1,800,000 in year three, 2,100,000 in year four and f1,100,000 in year five. All other costs will increase and be at 10% per year of the contribution margin. The working capital investment will be f1,500,000 in year three, and 55% of it will recover in the last year. The sales revenue will increase at 12% per annum, and variable cost will be 45% of sales. The company will follow a similar strategy for depreciation and promotional cost, just like the city centre. 2 19 3 will follow a similar strategy for depreciation and promotional cost, just like the city centre. Financing the investment The company has several choices for financing this expansion issuing new equity or bond or using existing retained earnings. The shares of Daffodil are traded in the Alternative Investment Markets (AIM) for 30, however, the face value is 20 and last year's dividend was f0.35. HSBC will charge a flotation cost of 10% to issue the new common stock in the market. There is a projection that the dividend will grow at 6% a year in the coming years. The firm can issue an additional long-term bond at an interest rate (before tax) of 10 % (i.e. Coupon rate). Currently, similar bonds are selling at f110, slightly over the face value (which is 100), with five years of maturity. The market risk premium is 5%, the 3-month UK gilt rate is 3.5% (risk-free rate), and the average Beta of the Electronic goods industry is 1.73. The company is also planning to issue preferred stocks. The industry average preferred dividend and current market price are f10 and 96, respectively. The company wants to maintain a capital structure of approximately 45% debt, 5% prefered equity and 50% of ordinary equity. The current corporate tax rate is 35%. Required a) Determine the Weighted Average Cost of Capital (WACC) for target capital structure. b) Evaluate which showroom should be selected (Hints: use NPV and IRR). Ms Victoria prefers to use CAPM (i.e., Capital Asset Pricing Model) over DDM (i.e., Dividend Discount Model). Advise, accordingly with appropriate assumptions and rationales for the future. (5+10+5 = 20 Marks) Victoria] PROFIT STATEMENTS (C million) Years 2016 2017 2018 2019 2020 Sales revenue 176.200 190.000 199.110 201.240 201.545 Cost of Sales 28.629 31.294 32.111 32.919 32.382 Gross profit 147.571 158.706 166.999 168.321 169.163 Fixed and semi-variable costs Fixed overhead 34.283 40.872 42.478 44.014 45.523 Promotion 5.000 6.000 7.000 8.000 9.000 Research and Development 6.000 6.500 7.000 7.500 8.000 Depreciation 31.500 49.400 51.350 53.300 55.250 New model launch 20.000 0.000 0.000 0.000 Professional charges 8.000 8.000 8.000 8.000 8.000 Stock upkeep 0.000 0.362 0.376 0.472 0.504 Total fixed and semi variable 104.783 111.134 116.203 121.286 126.277 Operating profit 42.788 47.572 50.795 47.036 42.887 Interest on loans 15.000 25.000 30.000 30.000 15.000 Profit before tax 27.788 22.572 20.795 17.036 27.887 Tax 9.726 7.900 7.278 5.962 9.760 Profit after tax 18.062 14.672 13.517 11.073 18.126 Dividends 10.000 10.000 10.000 10.000 10.000 Retained earnings 8.062 4.672 3.517 1.073 8.126 70%